1. Chapter 25: Pricing in Resource Markets Resource markets Resource demand The labor market Resource markets Resource demand The labor market

2. Factor/Resource markets Factors of production:  land  labor  capital  entrepreneurship factor prices determined in resource markets Factors of production:  land  labor  capital  entrepreneurship factor prices determined in resource markets

3. resources markets same concepts of demand and supply  now applied to factors of production same concepts of demand and supply  now applied to factors of production

4. resource demand producer will demand an additional unit of resource if MR of resource > MC of resource

5. example: Wal Mart labor market 1 more clerk costs $400 per week 1 more clerk increases revenue by $500 week hire 1 more clerk?  Yes! $500 > $400 labor market 1 more clerk costs $400 per week 1 more clerk increases revenue by $500 week hire 1 more clerk?  Yes! $500 > $400

6. example: lawn service capital market larger, faster mower costs extra $400/wk. but mow more lawns, extra $600/wk. in revenue buy the mower?  Yes! $600 > $400 capital market larger, faster mower costs extra $400/wk. but mow more lawns, extra $600/wk. in revenue buy the mower?  Yes! $600 > $400

7. termsterms marginal revenue product (MRP)  extra revenue from one more unit of resource marginal resource cost (MRC)  extra cost for one more unit of resource marginal revenue product (MRP)  extra revenue from one more unit of resource marginal resource cost (MRC)  extra cost for one more unit of resource

8. rule for resource demand firm hires additional resources until  MRC = MRP cost of the extra resource = extra revenue from the resource firm hires additional resources until  MRC = MRP cost of the extra resource = extra revenue from the resource

9. resource supply you will supply your resources to the “best” option  highest paying (if all else equal) nonmonetary factors are important  firms must compensate when jobs are dirty, dangerous, illegal….. you will supply your resources to the “best” option  highest paying (if all else equal) nonmonetary factors are important  firms must compensate when jobs are dirty, dangerous, illegal…..

10. The Market for Resources resource demand  downward sloping  producers less willing, able to buy resources at higher prices resource demand  downward sloping  producers less willing, able to buy resources at higher prices

11. resource demand is a DERIVED demand  it depends on the demand for the final product resource demand is a DERIVED demand  it depends on the demand for the final product

12. examplesexamples demand for nurses  depends on demand for healthcare demand for steel  depends on demand for cars demand for plywood  depends on demand for houses demand for nurses  depends on demand for healthcare demand for steel  depends on demand for cars demand for plywood  depends on demand for houses

13. Shifts in demand for a resource demand for final product  if product demand rises, MRP rises  resource demand shifts right productivity of resource  better resource, higher MP & MRP  resource demand shifts right demand for final product  if product demand rises, MRP rises  resource demand shifts right productivity of resource  better resource, higher MP & MRP  resource demand shifts right

14. examplesexamples increase demand for healthcare  increase demand for nurses  increase demand for syringes higher-skilled labor  increases demand for labor increase demand for healthcare  increase demand for nurses  increase demand for syringes higher-skilled labor  increases demand for labor

15. price of other resources  if price of substitute resource falls -- substitute cheaper resource -- demand for original resource shifts left price of other resources  if price of substitute resource falls -- substitute cheaper resource -- demand for original resource shifts left

16. exampleexample bank  ATMs vs bank tellers  ATM costs falls -- demand for bank tellers falls bank  ATMs vs bank tellers  ATM costs falls -- demand for bank tellers falls

17. exampleexample office buildings  skyscrapers in Manhattan  3 stories in Oswego why?  cost of land vs. cost of construction office buildings  skyscrapers in Manhattan  3 stories in Oswego why?  cost of land vs. cost of construction

18.  if price of complement resource falls -- use more of both resources -- demand for original resource shifts right  if price of complement resource falls -- use more of both resources -- demand for original resource shifts right

19. exampleexample price of trucks (18-wheeler) fall  increase demand for truck drivers price of trucks (18-wheeler) fall  increase demand for truck drivers

20. notenote sometimes resources are BOTH substitutes and complements:  computers do some clerical functions AND  need clerical workers to operate them sometimes resources are BOTH substitutes and complements:  computers do some clerical functions AND  need clerical workers to operate them

21. technology  decrease demand for some types of labor  increase demand for other types of labor technology  decrease demand for some types of labor  increase demand for other types of labor

22. exampleexample better/cheaper computer technology  increases demand for programmers  decrease demand for architects better/cheaper computer technology  increases demand for programmers  decrease demand for architects

23. resource supply  upward sloping  suppliers more willing, able to provide resources at higher prices resource supply  upward sloping  suppliers more willing, able to provide resources at higher prices

24. Q res. P res. S D P* Q*

25. resource prices tend to equalize across alternative uses  carpenters for houses  carpenters for furniture UNLESS other nonmonetary differences  economics professors vs. business economists  land in Manhattan vs. land in Oswego tend to equalize across alternative uses  carpenters for houses  carpenters for furniture UNLESS other nonmonetary differences  economics professors vs. business economists  land in Manhattan vs. land in Oswego

26. The Labor Market Labor supply Labor demand Earnings differences Labor supply Labor demand Earnings differences

27. Labor Supply time is a scarce resource  market work (for pay)  nonmarket work (not for pay) (cleaning, studying)  leisure (for fun) time is a scarce resource  market work (for pay)  nonmarket work (not for pay) (cleaning, studying)  leisure (for fun)

28. work and utility work is a disutility  but allows you to buy stuff  or to enjoy stuff (clean house, dinner, good grades) work is a disutility  but allows you to buy stuff  or to enjoy stuff (clean house, dinner, good grades)

29. tradeoff between consumption & leisure  work to buy stuff or to make stuff  but working leaves less time for leisure tradeoff between consumption & leisure  work to buy stuff or to make stuff  but working leaves less time for leisure

30. implicationsimplications higher wages = higher opp. cost of leisure, nonmarket work  most surgeons don’t mow their lawn  many college sports stars head to the draft early higher wages = higher opp. cost of leisure, nonmarket work  most surgeons don’t mow their lawn  many college sports stars head to the draft early

31. two effects:  substitution effect  income effect two effects:  substitution effect  income effect Effect of a wage increase

32. substitution effect as wage rises  opp. cost of other time uses rises  spend more time on market work Qs of labor rises as wages rise as wage rises  opp. cost of other time uses rises  spend more time on market work Qs of labor rises as wages rise

33. income effect as wages rise  income rises  consumer more of what you like: -- stuff, leisure Qs of labor falls as wages rise as wages rise  income rises  consumer more of what you like: -- stuff, leisure Qs of labor falls as wages rise

34. if substitution effect > income effect  labor supply is upward sloping if substitution effect < income effect  labor supply is downward sloping which is it? if substitution effect > income effect  labor supply is upward sloping if substitution effect < income effect  labor supply is downward sloping which is it?

35. labor supply economists observe  upward sloping for most wages  downward sloping at very high wages backward-bending supply curve economists observe  upward sloping for most wages  downward sloping at very high wages backward-bending supply curve

36. wage Q labor S subst. > inc. effect subst. < inc. effect

37. Changes in market labor supply adult population  births rates, immigration  increase will shift labor supply right adult population  births rates, immigration  increase will shift labor supply right

38. preferences  willingness of groups to work  women have increasingly entered labor force -- shift labor supply right preferences  willingness of groups to work  women have increasingly entered labor force -- shift labor supply right

39. skills, education, training  education increases opp. cost of not working for pay -- labor supply increases with education  increase HS, college graduation -- increase supply high-skill labor -- decrease supply low-skill labor skills, education, training  education increases opp. cost of not working for pay -- labor supply increases with education  increase HS, college graduation -- increase supply high-skill labor -- decrease supply low-skill labor

40. other sources of income  nonwage income lowers labor supply  less labor supply among those over 50 with the growth of pensions, disability  less labor supply among women with high-earning husbands other sources of income  nonwage income lowers labor supply  less labor supply among those over 50 with the growth of pensions, disability  less labor supply among women with high-earning husbands

41. Labor demand firm’s demand for labor car wash  perfectly competitive marginal revenue product (MRP)  change in total revenue when one more unit of labor is hired firm’s demand for labor car wash  perfectly competitive marginal revenue product (MRP)  change in total revenue when one more unit of labor is hired

42. example: car wash price of car wash = $3 car washes per hour price of car wash = $3 car washes per hour Q laborTP MPMRP 0 1 5 2 9 3 12 4 14 5 15 5 4 3 2 1 15 12 9 6 3

43. how much labor to hire MC of one more unit of labor  marginal resource cost (MRC)  wage MR of one more unit of labor  MRP hire until MRP = wage MC of one more unit of labor  marginal resource cost (MRC)  wage MR of one more unit of labor  MRP hire until MRP = wage

44. if MRP > wage  hire more labor and still add to profit if MRP < wage  last units labor taking away from profit, hire less labor if MRP > wage  hire more labor and still add to profit if MRP < wage  last units labor taking away from profit, hire less labor

45. wage Q labor 15 12 9 6 3 1 2 3 4 5 LD if wage = $9 hire 3 units labor

46. wage Q labor 15 12 9 6 3 1 2 3 4 5 LD wage = $6, hire 4 wage = $12, hire 2

47. Earnings differences based on both demand-side and supply side factors

48. Human Capital Skill set  Education, training, experience increases MP of labor & labor demand cost of education means supply of skilled labor lower relative to unskilled labor result is a higher market wage Skill set  Education, training, experience increases MP of labor & labor demand cost of education means supply of skilled labor lower relative to unskilled labor result is a higher market wage

50. ability/talentability/talent Human capital, but hard to measure the best athletes, most popular movies stars, CEOs command HUGE salary premium over others Human capital, but hard to measure the best athletes, most popular movies stars, CEOs command HUGE salary premium over others

51. Efficiency wage theory Higher pay leads to better productivity Why?  Better morale, lower turnover  “Cherry pick” the best workers  Workers do not want to risk losing job Higher pay leads to better productivity Why?  Better morale, lower turnover  “Cherry pick” the best workers  Workers do not want to risk losing job

52. Non-wage job characteristics Risk/danger Working conditions Work is meaningful or glamorous Holding all else constant, dangerous jobs pay more jobs with higher layoff probability pay more Risk/danger Working conditions Work is meaningful or glamorous Holding all else constant, dangerous jobs pay more jobs with higher layoff probability pay more

53. geographygeography wages higher in U.S.  encourages immigration teacher’s salaries vary significantly by state wages lower in South than Northeast wages higher in U.S.  encourages immigration teacher’s salaries vary significantly by state wages lower in South than Northeast

54. discriminationdiscrimination age, race, gender wage differentials remain EVEN after controlling for other factors  occupation  education/experience  risk age, race, gender wage differentials remain EVEN after controlling for other factors  occupation  education/experience  risk

55. unionizationunionization union workers earn more than nonunion workers doing the same jobs  janitors  auto workers  teachers union workers earn more than nonunion workers doing the same jobs  janitors  auto workers  teachers

56. 26. Markets for Capital and Natural Resources Financial markets Natural Resource markets Financial markets Natural Resource markets

57. Financial Markets Demand for financial capital Supply of financial capital interest rate financial capital = loanable funds Demand for financial capital Supply of financial capital interest rate financial capital = loanable funds

58. Demand for Financial capital firms demand funds to finance capital purchases higher interest rate, more expensive to borrow  lower Q demanded of funds firms demand funds to finance capital purchases higher interest rate, more expensive to borrow  lower Q demanded of funds

59. interest rate Q funds D

60. Shifts in demand for funds population growth  increase demand for goods,  increase demand for capital,  increase demand for funds population growth  increase demand for goods,  increase demand for capital,  increase demand for funds

61. technology  increase demand for new capital,  increase demand for funds to finance it technology  increase demand for new capital,  increase demand for funds to finance it

62. Government borrowing  Federal gov’t deficits shift demand to the right Government borrowing  Federal gov’t deficits shift demand to the right

63. Supply of Financial capital people’s savings decisions  tradeoff between consuming today & consuming tomorrow Time preference higher interest rates  encourage saving  higher opportunity cost of current consumption  higher Q supplied of funds people’s savings decisions  tradeoff between consuming today & consuming tomorrow Time preference higher interest rates  encourage saving  higher opportunity cost of current consumption  higher Q supplied of funds

64. Shifts in supply of funds population  higher population, more saving  supply shifts right income  higher income, more savings  supply shifts right population  higher population, more saving  supply shifts right income  higher income, more savings  supply shifts right

65. expected future income  save today based on future needs -- retirement, college  save to smooth consumption over time  expect income to rise -- save less today, supply falls  expect income to fall -- save more today, supply rises expected future income  save today based on future needs -- retirement, college  save to smooth consumption over time  expect income to rise -- save less today, supply falls  expect income to fall -- save more today, supply rises

66. interest rate Q funds S D Financial market equilbrium i* Q*

67. Natural Resource markets renewable resources  land, forests, livestock nonrenewable resources  fossil fuels, metals renewable resources  land, forests, livestock nonrenewable resources  fossil fuels, metals

68. Market for land supply is fixed for type or location  perfectly inelastic supply is fixed for type or location  perfectly inelastic

69. S rent Q land D r* Q*

70. economic rent rent for land is special  land is available even if rent=0  demand affects P, not Q economic rent  rent above what is required to induce Q supplied of factor rent for land is special  land is available even if rent=0  demand affects P, not Q economic rent  rent above what is required to induce Q supplied of factor

71. S rent Q land D r* Q* economic rent

72. Pure economic rent  Income earned by resource with a perfectly inelastic supply Pure economic rent  Income earned by resource with a perfectly inelastic supply

73. Economic Rent amount of resource earnings ABOVE opportunity cost or resource earnings – minimum required earnings “gravy”! “bonus”! amount of resource earnings ABOVE opportunity cost or resource earnings – minimum required earnings “gravy”! “bonus”!

74. example: Shaquille O/Neal 2000: $35 million what is minimum for which he would play basketball and endorse stuff?  suppose $1 million economic rent: $34 million 2000: $35 million what is minimum for which he would play basketball and endorse stuff?  suppose $1 million economic rent: $34 million

75. when do resources earn rent? less elastic (more inelastic) the supply,  more rent as a % of total earnings less elastic (more inelastic) the supply,  more rent as a % of total earnings

76. Differential rent Rents earned to superior units of a resource  Where quality of resource affects productivity Examples  Highly fertile farmland  Highly skilled trial lawyer Rents earned to superior units of a resource  Where quality of resource affects productivity Examples  Highly fertile farmland  Highly skilled trial lawyer

77. Inframarginal rent Total rent when units of resource differ in their opportunity costs What causes differences?  Differences in objectives  Differences in constraints Total rent when units of resource differ in their opportunity costs What causes differences?  Differences in objectives  Differences in constraints

78. examplesexamples Nursing  Find the work rewarding  Other constraints in the job market Teaching summer school  Presence of small children  Children in college Nursing  Find the work rewarding  Other constraints in the job market Teaching summer school  Presence of small children  Children in college

79. Q res. P res. S D P* Q* upward-sloping supply earnings split rent opp. cost

80. Supply of nonrenewable resource at point in time Q is fixed but over time  use -- decrease supply  new discoveries -- increase supply  technology for better use -- decrease demand at point in time Q is fixed but over time  use -- decrease supply  new discoveries -- increase supply  technology for better use -- decrease demand

81. example: metals nonrenewable resource discover new sources use substitutes (plastic) Recycling technology nonrenewable resource discover new sources use substitutes (plastic) Recycling technology

82. Market-guided conservation Markets have built-in incentives for efficient resource use If a resource becomes scarce  Prices rise Copper is up 50% in 2006 Markets have built-in incentives for efficient resource use If a resource becomes scarce  Prices rise Copper is up 50% in 2006

83. If prices rise  People use less (conserve)  People substitute  Firms look for new sources  Firms look for alternatives If prices rise  People use less (conserve)  People substitute  Firms look for new sources  Firms look for alternatives

84. Problems with markets & nonrenewable resources Externalities  Extraction of oil, metals, natural gas have huge negative externalities  Market results in too much extraction Government policies  Major tax breaks to domestic energy producers Prices may not be sending the right signals Externalities  Extraction of oil, metals, natural gas have huge negative externalities  Market results in too much extraction Government policies  Major tax breaks to domestic energy producers Prices may not be sending the right signals

85. Doomsday scenarios Aka “We are running out of everything and we are all going to die” Aka “We are running out of everything and we are all going to die”

86. Paul Ehrlich The Population Bomb, 1968 "a major food shortage in the United States in the 1970s...hundreds of millions of people are going to starve to death." By 1999 U.S. population would be only 23 million (actual 1999 U.S. population = 288 million) "a major food shortage in the United States in the 1970s...hundreds of millions of people are going to starve to death." By 1999 U.S. population would be only 23 million (actual 1999 U.S. population = 288 million)

87. Limits to Growth 1974 World will run out of gold by 1981 mercury by 1985 tin by 1987 zinc by 1990 petroleum by 1992, and copper, lead, and natural gas by 1993 World will run out of gold by 1981 mercury by 1985 tin by 1987 zinc by 1990 petroleum by 1992, and copper, lead, and natural gas by 1993

88. An economist’s refutation: Julian Simon The Ultimate Resource (1983) Hoodwinking the Nation (1999) Doomsayers underestimate human ingenuity Julian Simon The Ultimate Resource (1983) Hoodwinking the Nation (1999) Doomsayers underestimate human ingenuity

89. Simon vs. Ehrlich Made a bet in 1980 for $1000 Simon bet price of 5 key metals would be LOWER in 1990  Signaling less scarcity Simon won. Ehrlich paid  Simon offered to renew the bet, Ehrlich refused Made a bet in 1980 for $1000 Simon bet price of 5 key metals would be LOWER in 1990  Signaling less scarcity Simon won. Ehrlich paid  Simon offered to renew the bet, Ehrlich refused

91. Real concerns about resources today: Has natural gas production peaked Will oil production soon peak? Has natural gas production peaked Will oil production soon peak? Hubbert’s curve

92. Are we running out of copper? Are we past the tipping point on global warming? BUT…. Doomsayers need to take some responsibility for lack of world action Are we running out of copper? Are we past the tipping point on global warming? BUT…. Doomsayers need to take some responsibility for lack of world action